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«January 16, 2006 Howard Pack Kamal Saggi The Wharton School Department of Economics University of Pennsylvania Southern Methodist University 1400 ...»

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The circumstances just described suggest that idiosyncratic events - the Y2K problem and the shift to the Euro - exerted positive feedback and generated a succession of mutually reinforcing benefits. In terms of industrial policy, of whatever form, it seems unlikely that any government could have foreseen and acted upon these serendipitous demands. The government’s main contribution had been to provide high quality university education.22 B. The foreign role One of the major contributors to the Indian software sector was the large number of expatriate Indian IT professionals located in Silicon Valley. The prominence of Indian expatriates in Silicon Valley has been remarkable. In 1998, 774 (or 9%) of the high technology firms were led by Indian CEOs.23 Many of them helped to convince large firms such as Oracle, Novell, and Bay Networks to establish operations in India.24 Aware of the obstacles some Indians face in raising capital for their software startups they actively raised venture capital from U.S. investment firms and organized conferences in the U.S. to heighten the awareness of the potential of India’s software industry.25 Finally, some of these expatriates were actively involved in lobbying efforts urging the Government of India to revamp its telecommunication policies and other regulations that had impeded the growth of the Indian software industry26.

FDI accounted for a large percentage of early investment in the sector. For example, in 1996, foreign companies accounted for 70% of the investment in software Some observers felt this was an incorrect allocation of education funds and the returns would have been greater to more extensive and higher quality primary and secondary education. The success of the software sector does not disprove this earlier view. For example, the favorable effect on the adoption of the green revolution package on the income of Indian farmers of even lower levels of education are well established.

James (2000).

Saxenian (1999).

Kripalani (2000).

Kirpalani (2000).

development in Bangalore.27 And this contribution understates the true impact. Texas Instruments (TI), the first foreign firm to establish an offshore software facility in Bangalore in 1984 augmented Bangalore’s inadequate land-based telecommunication infrastructure by investing in its own satellite communications network, in conjunction with Videsh Sanchar Nigam (VSNL), the government’s overseas communication agency.28 Some of TI’s lines were later leased to other software firms, enabling them to expand their India-based operations instead of relying solely on onsite services abroad.

Until the government built software technology parks in the 1990s linked to earth stations and other telecommunications infrastructure, TI’s satellite network remained an important driving force behind the offshore development of software exports.

Once U.S. based firms had become interested in India, Bangalore’s reputation for technical excellence and its abundant supply of IT graduates from its 3 universities, 14 engineering colleges and 47 polytechnic schools made it a natural choice for foreign companies to locate their software business there.29 The foreign role has been of major importance as it provided much of the infrastructure and international knowledge that allowed Indian firms to exploit international opening. In addition, Indian software firms also benefited from foreign joint ventures and partnerships because they create markets for Indian software exports. At the same time these firm provide distribution networks for Indian firms attempting to move upstream. Moreover, partnerships with foreign firms add to the credibility to an Indian firm and act as endorsements of its quality and reliability without government encouragement. The advantage seems to have been firm specific ala Grossman-Horn rather than Mayer. Thus, other foreign firms looking to outsource their software development would invariably choose a software firm with a proven track record with another foreign company. Lastly, for small Indian firms attempting to move out of the low-end of the software business by venturing into software packages, having foreign partners is an asset because of their established distribution networks, knowledge of the recent trends in the software market (due to proximity to the demand in the U.S.) and significantly lower marketing costs. Since as The Economist (1996).

The telecommunications industry in India is state-controlled, hence the need for TI to procure the services of VSNL instead of a private firm.

Stremlau (1996a).

much as 70% to 80% of the final price of a software package arose from marketing costs (Lakha, 1994), small Indian firms without a known brand, an extensive sales network or sufficient revenue found it more profitable to sell its packages via a foreign collaborator.

How does this experience of a very successful sector square with the many strands of new industrial policy. All of it was privately initiated, governments at various levels became involved only after the success of the sector was evident, ratifying the success rather than catalyzing it. The industry expanded on the basis of comparative advantage and never needed any protection. Indeed, one advantage of the software sector was that its inputs, largely downloads from satellites and its output, uploaded to satellites, could not be easily taxed by the Indian authorities. A symbiosis of foreign and domestic firms was critical. Though there was clearly an agglomeration of firms in Bangalore this was achieved spontaneously without government direction. Foreign contracts rather than government subsidies provided the basis for international exploration of markets. There is no evidence of government initiation or preference.

5. Is industrial policy still relevant?

From Hamilton and List to contemporary discussions of industrial policy, the implicit framework has been that of a firm producing tradable goods at an initial cost disadvantage given the limited industrial history of the country, learning to become more efficient, and then competing with imports in the local market or successfully exporting.

The marketing of the efficiently manufactured product was implicitly assumed to be routine. Reduction of production costs whether through internal learning-by-doing or through spillovers within industrial clusters was viewed as paramount. In discussions of post-war Asian experience some attention was given to the catalytic role of Japanese, Korean, and Taiwanese trading companies in assembling large quantities of goods and achieving scale economies in marketing but this activity was not given center stage (Lall and Keesing, 1992). Even if countries could now pursue the export oriented policies of four decades ago in Korea and Taiwan (China), it is not clear that they would be efficacious given the changed nature of both retailing and production networks.

In the last two decades there has been a shift in the institutional mechanism of international trade. Two types of organization have evolved: (a) international production networks, IPN, in which a producing firm organizes large numbers of suppliers in a number of locations; (b) buyer-led networks in which large retail chains provide specifications for the desired final product and encourage suppliers in developing countries to organize their own production system that most often includes large numbers of local subcontractors.30 These networks have become increasingly important, and are dominant in clothing and electronics and growing in importance in other products such as automotive components. In East Asia in recent years components “constitute at least a fifth of manufacturing exports and … have typically grown 4-5 percent faster than overall trade in East Asia.” (Yusuf et. al., 2003, p. 272).

One effect of the growing importance of IPNs is their efficiency at organizing production and continuously reducing costs so that the global price that non-member firms must compete with shifts down rapidly. Infant firms undergoing learning face other hurdles: rapidly improving quality; changing characteristics of existing products and an array of new goods that compete with existing ones (Ernst, 2002). For firms attempting to enter export markets, it cannot be assumed that simply achieving low cost is sufficient to realize foreign sales. There is no guarantee that lead firms will be able to identify one or two firms in a small African nation. The existence of supply networks imposes a significant challenge to LDC firms that are not embedded in such a network as the lead firms usual succeed in generating higher performance in design, engineering, the effective use of information and communication technology, and the ability to coordinate production in several locations. (Yusuf et. al., p. 278).

Further militating against the classical view of infant industries is the change in the nature of retailing. Consider a mundane product such as socks that can be produced efficiently with relatively labor intensive technology. Huge retailers such as Walmart and Target buy these in quantities that typically exceed the production capacity of small (by international standards) industries. The special economic zones in China have become a series of clusters that produce enormous quantities of socks, ties, and other clothing.

Retailers and wholesalers place very large orders that are well beyond the production capacities of smaller firms even if these have learned sufficiently rapidly to become cost A good description of these alternatives and evidence on their quantitative importance is given in Gereffi, 1999. See as well Yusuf et. al. (2003) Chapter 7. Sturgeon and Lester (2002), and UNCTAD, 2001 competitive in relatively small quantities. “These days buyers from New York to Tokyo want to be able to buy 500,000 pairs of socks all at once, or 300,000 neckties, 100,000 children’s jackets…” (Barboza, 2004). European firms buy smaller, more varied products but expect local suppliers to provide “in-house design and sample making capabilities that would allow them to translate and adapt the design from Europe.” (Sturgeon and Lester, 2002, p. 49).

In textiles, clothing, electronics, auto parts and other sectors, being a part of an IPN is critical to exporting and upgrading of quality. Firms that are not part of such networks may not succeed even if they are as efficient as members in production costs.

Local participants in the network must “label track, respond to product orders in real time on the basis of style, color, fabric, and size; exchange information on an... electronic basis, provide goods to a retailer’s distribution center that can be efficiently moved to stores … including containers with bar codes concerning contents” (Yusuf, p. 283).

These requirements, now fairly standard in many product areas, suggest that successful penetration of OECD markets will become increasingly difficult for nations that have not yet industrialized.

In electronics, an important efficient, labor-intensive growth sector in the past for many of the Asian countries, much of the production is now carried out by contract manufacturers whose size has grown enormously in the last decade. Firms such as Solectron and Flextronics now undertake activity that was formerly under the aegis of major developed country firms who have outsourced the activity. Examining the location of several activities: headquarters, manufacturing, materials purchasing and management, new production introduction centers, and after sales repair centers, Sturgeon and Lester (2002) show that most of these activities of Solectron, the largest of the contract manufacturers, take place in developed countries or the more advanced semiindustrialized nations contiguous to them such as Mexico, Puerto Rico, Romania, and Turkey. Ernst, 2002 (p. 24) confirms these results and points out that specialized clusters in countries such as the Nordic nations, the U.S., France, and Germany are major sources as are Singapore, Hungary, Israel, Korea, and Taiwan (China). Poorer countries even if

provide evidence on the empirical importance of the IPNs.

they have a potential cost advantage after a long learning period will have trouble breaking into these existing networks.

Moreover, China and India present formidable competitors as demonstrated by the concern over the termination of the multi-fiber agreement and the potential losses incurred by nations that formerly had guaranteed access to OECD markets. While it might be argued that the two giant nations will encounter rising wages and thus enter more capital and technology intensive sectors, providing room for new countries, both still have hundreds of millions of workers, largely in the rural sector, who remain poor and will keep a lid on the real wage faced by industrialists over the next decades, implying a continuing supply of low cost products in many sectors. While in principle poorer nations can find a niche in which they have a comparative advantage, finding them is likely to require a vector of skills that are best nurtured by membership in a production network or direct interaction with large retailers.

Viewed from the perspective of potential government policies the growing importance of production networks suggests an array of potential interventions. Korea and Taiwan (China) had numerous trading companies that aggregated orders of local manufacturers, following the Japanese model of the shosha soga. Most of these arose spontaneously from private efforts. Governments could attempt to encourage the development of trading companies as there may be a market failure given the characteristic that setup costs for such a firm may be significant but marginal costs of adding firms to the network may be small. Such trading firms would operate across clusters of manufacturing firms. Again, this assumes that there are capital market failures that preclude a nascent trading firm from obtaining finance.

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